Alternative places to put money

Second, low interest rates on investments such as CDs motivate investors to consider alternative places to put their money, and a prime alternative is the stock market. The stock market always takes a big hit during recessions. For example, during the Great Recession, the U.S. stock market fell 40 percent. This kind of loss not only hurts investors and business owners, but it also destroys jobs and salaries as firms are forced to cut-back and downsize.

The Fed’s viewpoint is that low interest rates will pump up the stock market, restore investor and business confidence and help rekindle hiring. Indeed, the U.S. stock market has recovered most of its losses, business confidence has improved and more than 6 million payroll jobs (200,000 in North Carolina) have been added in the country during the last three years.

The Fed’s low interest rate policy has not escaped criticism. Safe investors like my late father rightly complain about the paltry earnings they’ve received. There’s also the worry that the gains made in the stock and job markets may be a form of “sugar high” created by the Fed’s low rates. Take the sugar (low interest rates) away, and crashes could occur.

Then why wouldn’t the Fed keep interest rates low forever? For one, they may not be able to, as economic forces beyond their control could push up rates, especially if the economy continues to improve and borrowing increases. Also, super-low rates don’t give the Fed any room to further decrease them if another recession happens. Last, the low interest rates must ultimately be supported by aggressive money printing, which, some argue, can eventually generate significantly higher inflation.

This is why most Fed-watchers are convinced the bank will eventually increase interest rates; so it’s not an “if” but a “when.” Already, longer-term interest rates, which the Fed does not directly control, have been edging higher.

Higher interest rates will present many questions for the economy. How will the stock market react? Some analysts say it will drop, but others say it will only hiccup and then resume rising. How will borrowing be affected? For those with jobs and good income potential, loans will likely still be possible. But marginal borrowers may be cut out.

Also, don’t forget the impact on the federal government of a higher interest rate environment. Although the national debt is at a record high, interest payments on the debt are not, thanks to extraordinarily low interest rates. Every increase in interest rates creates more costs for the federal government in funding the national debt and makes our public debt problem more difficult.

The Federal Reserve knows all this. The conventional wisdom is that the Fed won’t move to increase interest rates until the bank is convinced the economy can absorb the costs and still continue to grow. Of course, as my wife likes to say, this is a judgment call, which can be correct or wrong. At some point, you and I will decide what grade to give the Fed on their call!